Stock Analysis

Is The Hershey Company (NYSE:HSY) Worth US$239 Based On Its Intrinsic Value?

NYSE:HSY
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Key Insights

  • Hershey's estimated fair value is US$180 based on 2 Stage Free Cash Flow to Equity
  • Hershey is estimated to be 33% overvalued based on current share price of US$239
  • Analyst price target for HSY is US$247, which is 37% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of The Hershey Company (NYSE:HSY) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Hershey

Step By Step Through The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$1.62b US$2.02b US$2.02b US$1.87b US$1.99b US$1.98b US$1.99b US$2.01b US$2.04b US$2.07b
Growth Rate Estimate Source Analyst x6 Analyst x6 Analyst x5 Analyst x1 Analyst x1 Est @ -0.24% Est @ 0.45% Est @ 0.94% Est @ 1.28% Est @ 1.52%
Present Value ($, Millions) Discounted @ 6.8% US$1.5k US$1.8k US$1.7k US$1.4k US$1.4k US$1.3k US$1.3k US$1.2k US$1.1k US$1.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$14b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.1%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.8%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$2.1b× (1 + 2.1%) ÷ (6.8%– 2.1%) = US$44b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$44b÷ ( 1 + 6.8%)10= US$23b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$37b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$239, the company appears potentially overvalued at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
NYSE:HSY Discounted Cash Flow February 27th 2023

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Hershey as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 6.8%, which is based on a levered beta of 0.800. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Hershey

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Food market.
  • Expensive based on P/E ratio and estimated fair value.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
Threat
  • Annual earnings are forecast to grow slower than the American market.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a premium to intrinsic value? For Hershey, we've put together three relevant factors you should assess:

  1. Risks: We feel that you should assess the 1 warning sign for Hershey we've flagged before making an investment in the company.
  2. Future Earnings: How does HSY's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

Valuation is complex, but we're helping make it simple.

Find out whether Hershey is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.